Conifex Timber Inc.

Well, thank you, Patrick, and good afternoon, everyone, and welcome to this call covering our first half 2021 results. I am joined today by Chief Financial Officer, Winny Tang; and Operating Head, Andrew McLellan.

After a few brief opening comments, I'll hand the call over to Andrew to review operations and Winny to review our financials. I then plan to review some important near-term developments that we believe will strengthen competitiveness and future cash flow generation at our Mackenzie complex, we will then respond to any questions that shareholders and analysts may have.

But first let's quickly deal with the housekeeping items. We will be making forward-looking statements and references to non-IFRS measures, and therefore call your attention to the warning statements set out on Pages 1 and 2 of the MD&A that we released earlier today.

For the second quarter, our net earnings were $26.1 million equivalent to $0.56 per share, EBITDA was $37.8 million. This brought our first half results net earnings up to $30.6 million or $0.66 a share and first half EBITDA up to $47.5 million.

The sequential improvement in quarterly earnings was driven by dramatically higher lumber prices, improved lumber shipments, that's railcar supply normalized, and $2.8 million in business interruption insurance proceeds. The settlement we reached with our power generation plant ensure, verifies the statement vendor and I made on previous call to the effect that neither employers nor [indiscernible] and maintenance procedures triggered the curtailment at the power plant.

I'll now turn the meeting over to Andrew who will update you on our lumber and power businesses.

Thank you, Ken, and good afternoon, everyone. First, I wish to reemphasize our number one priority is to protect the health and safety of our employees, their families, and community members.

Towards the end of Q2 and so far in Q3 successfully achieving this objective became more of a challenge to me. The heat wave in our home province result in wildfires led to harvest curtailments triggered some shift cancellations at our sawmill in Q2.

We also incurred extra cost tracking lumbers to service our customer base when railcar supply was sporadic. We owe a debt of gratitude to our employees who helped us maintain a safe workplace in the COVID pandemic and help mitigate disruptions in log and railcar supply.

We also thank our contractors who made their equipment [indiscernible]. On my last two calls, I know that the combination of heavy snowpack and wet weather last spring extended the spring breakup period and led to log harvest and delivery shortfalls at mills in the northern interior region of British Columbia.

Consequently, our sawmill operated at 83% of capacity in the first half of 2021. Now that our log inventories are being replenished through our active summer logging programs, we plan to extend operating hours at our Mackenzie mill later this month.

Our MD&A disclosures that we are targeting an operating rate of 90% in Q3 and even higher rate in Q4. As always any number of unanticipated pandemic evolved by related production or shipment disruptions could hold us back and prevent us from achieving these production targets.

Our power business performed well in the quarter and continues to meet its production targets going forward. I will now turn the discussion over to CFO, Winny Tang.

Thank you very much.

Thank you, Andrew, and good afternoon, everybody. We ended Q2 with cash of $35.8 million and available liquidity of $45.8 million.

The $10 million revolving credit facility we arranged late last year remains undrawn. Gross debt at the end of the quarter totaled approximately $62 million of which $59 million is limited recourse debt related to over a $100 million investment in green power production.

We also have obligations totaling $2.7 million for leased office spaces and mobile equipment. After deducting cash, we ended the second quarter with net debt of $20.1 million and a net debt to capitalization ratio of approximately 12%.

Our lumber business is in an enviable financial position with nominal debt and significant cash balances. We deposited $7.8 million in duties in the first half of 2021 and we now have US$16.3 million on deposit as potentially refundable.

Our capital expenditures totaled just under $3 million in the first half of 2021 and we expect to spend a similar amount in the second half of the year. We also expect to pay minimal cash taxes this year and also into the next year as well.

In December 2020, we commenced our normal course issuer bid entailing us to repurchase and cancel up to 2.94 million shares. In the second quarter, we repurchased and cancelled 1.45 million shares.

Since inception, we have repurchased and cancelled 2.3 million shares at a total cost of $5.5 million. Our average purchase price of $2.31 per share represents a 28% discount to our June 30 book value of $3.21 per share.

Subsequent to the quarter end, we amended our credit agreement to allow us to repurchase and cancel up to $9 million of our shares between October 1, 2021 and September 30, 2022. For reasons that Ken will discuss, we believe our share trades well below our estimate of fundamental value, and we view the share buybacks as an optimal use of excess cash.

I will now turn the meeting back to Ken.

Well, thanks, Andrew and Winny. Since delivered log costs account for about three quarters of the cash costs that producing lumber in the interior region of BC, the competitiveness ranking of any sawmill complex is driven by the procurement costs and quality of the available sawlog supply.

We think it makes sense to use the remaining time today to bring you up to date on our fiber supply situation. We've summarized key information about the Mackenzie timber supply area in Slides 7 and 8 in the deck we distributed.

The Chief Forester has indicated that she expects to release an updated harvest level determination, and these are commonly referred to as allowable annual cut or AAC determinations. But she plans to release the new determination for the Mackenzie TSA before the end of 2021.

Under the new AAC determinations, we believe we will have ample access to better quality sawlogs. Here is why.

First, let's discuss trends of log quality at Mackenzie. As indicated in Slide 7, The Chief Forester presently requires operators at Mackenzie to source the majority of their sawlog requirements from dead and damaged pine stands.

Last year, the Ministry disclosed that 60% of the dead pine and the timber inventory in the Mackenzie TSA had lost commercial value and that’s no longer suitable for lumber production. With this disclosure, it is evident that the shelf life of the remaining beetle damaged stands in the Mackenzie TSA has expired.

This explains why we expect to be able to access a higher quality greener log diet in 2022 and beyond. Our greener log diet provides us opportunities to materially improve the lumber recovery.

Here, of course, we have fewer defects in the logs and more of each log is available at finished lumber. It also allows us to reduce unit cash conversion costs because we have fewer production jam-ups in our saw lines in our planning and finishing lines, and probably most important of all that allows us to boost our lumber grade outturns, which leads to much higher average lumber selling price realization.

In this ladder area with a green log diet, we believe we can move about 10% of the output of the mill from low grade lumber, which sells for something like a discount of a $100 per thousand board feet below construction grade lumber prices. We think we can move about 10% into a premium grade, which sells at about a $100 premium.

So you can see that the effect of a greener log diet is for something like US$20, or I should say, C$20 after duty and with $200 million plus annual lumber capacity. That's a swing in cash flow generation of over $4 million a year.

So this is why we are excited about this and we believe that with the redetermination of the harvest level of mix that it will migrate to a lower position on the global softwood lumber industry cost curve. Let me talk a couple of minutes about log availability.

Based on our review of the future AAC from the interior region of BC, in general, Mackenzie in particular, we believe that the Mackenzie TSA will likely contribute at least 6% of the total harvest in the interior region of BC. Since Canfor closed its Mackenzie mill in 2019, we operate the one remaining sawmill complex in the Mackenzie TSA.

At capacity, our mill will consume about 2% of the interior BC AAC. If the Canfor mill restarts at capacity, it could consume about 2.5% of the interior BC AAC.

So given that the Mackenzie TSA is expected to account for about 6% of the total fiber of the interior BC, that consume only 4.5% of the fiber as compared to total sawlogs are available to us in Mackenzie. And this explains that notes that we put at the bottom of the Slide 6, which makes the statement that we have one of the highest degrees of timber self-sufficiency of any sawmill operator in British Columbia.

So in anticipation of just having chemical supplies for better quality sawlogs, we've got three comprehensive studies that are underway. The first study examines the scope and scale of a potential modernization and expansion of our Mackenzie sawmills rating.

We believe we have a solid opportunity to boost lumber production capacity by about 25%, reduce cash conversion costs and further improve lumber recovery grade outcomes in sales realization. Our objective to identify a plan that enables us to sustain positive cash flow when lumber prices are at cyclical lows and the plan that produces attractive returns on investment even under conservative lumber prices assumptions.

The second study we have underway focuses on the diameter class quality characteristics and moisture content of the sawlog supply we expect to the access over the next decade and possibly longer. This crucial information will help us specify machine center and dry count attributes and performance requirements for any modernization project.

Our third study that we have underway focuses on the potential to build and operate a log merchandising facility at our Mackenzie site to process our internal requirements, but also to optimize the potential proceeds from the sale of surplus sawlog travel to the Mackenzie and sourced a fiber deposit sawmills in [indiscernible]. We expect to finalize these three studies shortly after the new AAC determination is announced.

We also expect that any projects we may approve in the future will be phased in over time and funded through a combination of our cash balances, potential export duty rebates or refunds and drawdowns under our existing credit facility. While we await the release of updated harvest level and mix determination, we intend to continue to repurchase and cancel shares.

We have equity in our power plant that we value at over a $1 per Conifex share, cash on our balance sheet was over $0.80 per share and duty refunds worth as much as $0.45 per share. This totaled $2.25 per share.

Our recent trading price is $0.50 per share lower than the total of these three items. Clearly, stock market investors presently record a negative value to our tenures and sawmill complex assets that we believe are valuable and that we are proud to own.

Therefore, we continue to believe that our stock is undervalued by a huge amount given the robustness and quality of the timber inventory in the Mackenzie TSA and given the high return capital investment opportunities available to Mackenzie. That's sums up the key points to monitor me.

We very much look forward to our next call with you, and we would be pleased to respond to any questions shareholders and analysts may have. So we'll turn the meeting back to Patrick.

Paul Quinn, RBC. Sure.

Okay. I'll ask few questions.

Hey guys. Now that you've got your balance sheet in good shape, again, just what you are looking to do?

Is it less? Are you looking to get back into M&A?

Or is it more upgrades in the sawmill?

Paul, good question. Today, all of our study and analysis has been focused on internal enhancement projects optimizing our existing timber and sawmill and power plant phase.

We have not been looking for external acquisition opportunity. The rationale, importantly driven by the fact that when we remain with internal project you can control the scope and scale and speed of the funding that's required and so that’s why we are continuing to look internally.

Okay. Then maybe you've got a pretty hot summer going here.

I just wonder what the update on fire situation is in Mackenzie. Whether you expect any shuts to occur in Q3?

Yes. Good afternoon, Paul.

It’s Andrew McLellan here. We've been fairly fortunate with the conditions in Mackenzie and somewhat different than we've seen in the summer in BC.

So we're not anticipating that we'll have anything out of the ordinary here in the back half of August to end of September. We did have some disruptions in Q2, but it was limited to about two weeks of shortfalls in August.

Deliveries would entirely shut down in log deliveries, but we had two periods that were impacted by fires.

Okay. And then, Ken, you mentioned that log costs BC interior is about 75% of cash costs, you obviously got hit with a huge run-up and stumpage on July 1, and poised to see another price increase on October.

Are you guys able to make cash at these levels of stumpage costs given the quality of the fiber you're bringing in?

Well, let me mention a couple of things about that, Paul, and they're both very good questions. First of all, we found that the heavy snowpack and difficult weather conditions that we had in Q1 forced us to incur extra log costs, buying wood to make up for some shortfalls that we experienced and spending extra money by pushing up growth.

So we kept hauled when ground conditions were very wet. So as a consequence of that, our non-stumpage-related sawlog costs in the second half of this year will be lower than they were in the first half, and stumpage will be a bit higher.

So all the reviews and scrubbing of numbers we've got indicate that we are going to have a modest single-digit increase in delivered log costs in the second half of the year compared to the first half. Coming back to the question – your second question is that, I think Paul, that if you looked at our operating earnings in the first six months of this year and divided it by 93.3 million board feet of shipment, you find that we had something like $450 of operating income per thousand board feet, and there's probably $25 or so of depreciation in that.

But in any of that, the operating income is right around $450. And through to last Friday, our average selling price realization was about C$450 lower than it was in the first half of this year.

So right today, we are at approximate breakeven and in the quarter-to-date, it would have been slightly ahead of our cash costs. But now we're about to experience a sub $500 benchmark price orders that will be shipping, so we've probably dipped into negative cash flow territory right now.

But at this moment, we're continuing to – as Andrew said earlier, we've got a robust summer logging program that enables us to spread our fixed costs over a larger number of units. And we are also looking at adding hours to our sawmill complex and we think that will enable us to reduce our cash conversion costs a bit.

So right at this moment, there's not an overwhelmingly powerful argument to take downtime because it's not clear to us yet that the procurement cost would be materially different than our operating loss. But who knows what will happen.

Our own view is that the correction in lumber prices have largely run its course and now we've got some seasonal improvement opportunities in shipments that are coming up and you and others are great competitors, so there could some restocking in certain lumber market segments. So we think lumber prices are more likely to go up from here and there is some urge of need to consider downtime at this moment.

Okay. A fulsome answer.

Maybe just lastly, just quite confused with your hedging strategy, it seems like, I’ve seen quarters where lumber prices are going up and you've had losses and lumber prices are going down when you've had losses. So maybe you can just remind us what your hedging strategy is and when it's going to start to work for you, I guess?

Are we still on the conference?

Okay. Well, good afternoon once again, everyone.

It's Ken Shields. We've had an unusual development with the phone system here, and we got dropped from the call.

So presumably you're still on the line. And I was in the midst of answering Paul Quinn’s question about our hedging strategy.

And it is – the background to our hedging strategy is that we did obtain some price protection and then we experienced this incredible run up in lumber prices and we took significant losses in Q2 – or if I mean in Q1. We took further losses in April of Q2, and towards late May, early June in Q2, we unwound positions and we did not – we ended up covering our position at much higher than the $500, $600 level that they reached at the end of the quarter.

And so there was a bit of a loss in Q2 in addition to Q1. We have no positions on the books now and we don't anticipate doing anything materially in the hedge market at this time.

So Patrick, are there other questions?

Done. I’m good.

Thanks very much Patrick.

Hugh Cooper. Ken, just two quick questions.

First of all, how much is your tax loss carryforward in the U.S. and what is left in Canada?

I can take that question. This is Winny Tang.

We have losses in excess of C$100 million in the U.S., and in Canada, we had around $50 million at the end of 2020, and so we were able to utilize a large portion of that so far in the year. But we do not expect to have any cash taxes payable for the current year.

Okay. And Ken, one – I think I might've missed that, but I think you said you had roughly about $0.80 a cash.

The duty refund roughly amounts about $0.45. Your lumber operations were a dollar and the biomass plant was it dollar?

No. We said the biomass plant was dollar.

The $45 million for the biomass only?

Yes. For the equity in the biomass and then there's $60 million of debt on top of that.

So it's roughly $105 million. So it's 7x EBITDA roughly.

Yes. And so we've said that, we infer from that that our tenures of lumber business had a negative value built into the current stock price.

Okay. And how would you value your cut or whatever your reduced cut will be?

How do you – do you see that as an asset?

We certainly do see it as an asset at Mackenzie. And we think that since we sold tenures at approximately $120 per cubic meter a while ago, we think tenure values have come down a bit in BC because of the regulatory uncertainty related to First Nations reconciliation efforts and some of the objectives that are set out in the Intentions Paper that the Ministry of Forest issued recently gives the province more flexibility to wheel and deal in 10 years than to repurchase tenures.

So I don't know, $90 or $100 might be the going rate. And we've got presently 807,000 cubic meters of tenure, 780 to 500, actually.

And then sawmills are valued at, I don't know, $400, used sawmills US$400 per thousand board feet of annual capacity where we've got a 240 million board feet now. So there might be a $100 million there or something like that.

And to the nearest total dollar, there might be $2 per share on above some of those other announced stuff we discussed.

Okay. Thanks.

That's it for me. Thanks very much, Ken.

Thank you, Hugh.

Well, I just want to thank all of you for your support of Conifex and for bearing with us since we had this telephone interruption today. So thank you.

We look forward to chatting to you in early November. Bye.